OTS recommends major shake-up of IHT Regime
The Office of Tax Simplification has published the second part of its report into simplifying the UK’s Inheritance Tax rules.
The Office of Tax Simplification (OTS) has published the second part of its report into simplifying the UK’s Inheritance Tax (IHT) rules. Following a consultation process, the OTS has made 11 recommendations for the government to consider, addressing three key areas of IHT:
- Lifetime gifts
- Interactions with Capital Gains Tax (CGT)
- Businesses and farms – Agricultural Property Relief (APR) and Business Property Relief (BPR).
There are currently a number of exemptions from IHT relating to lifetime gifts. Most of these exemptions have not changed since the 1980s and need updating. The OTS recommends that the various gift exemptions currently available should be simplified and consolidated and suggests the possibility of replacing these with a single, higher personal gifts allowance.
The OTS has further recommended that the government should reduce the “seven year rule” for lifetime gifts to five years and abolish taper relief. Under the current regime, where a person makes a lifetime gift, they must outlive the gift for a period of seven years for its value to be outside of their estate for IHT purposes. If they die within seven years, the value of the gift is included within their estate when calculating the amount of IHT due on their death. Taper relief can apply to reduce the applicable rate of tax to a gift made within seven years of death on a sliding scale.
The OTS has also recommended the abolition of the “normal expenditure out of income” exemption which many have found valuable but which does require proper record-keeping and is complicated to claim and assess.
If implemented by the government, the OTS proposals would make the lifetime gifting regime much simpler. Living individuals could benefit from more relaxed rules when considering their own estate planning. It would significantly simplify the reporting requirements for personal representatives following a death, by not having to look back as far into the history of the deceased’s gifting and by removing the need for complex taper relief calculations.
Under the current regime, the liability for paying any tax due on a lifetime gift (for example, where the donor of the gift dies within seven years) falls on the recipient of the gift. The OTS has recommended changes to shift liability onto the deceased donor’s estate. Although this would make calculating the tax due more straightforward for HMRC, it could be problematic in circumstances where there are insufficient assets in the estate to settle the tax, or where there are different beneficiaries in lifetime and on death.
Interactions with Capital Gains Tax
According to the OTS report, the government should consider removing the capital gains uplift on death where a relief or exemption from IHT applies (such as a spouse exemption, APR or BPR). Instead, the OTS suggests, the recipient of an asset on death should be treated as acquiring the asset at the historic base cost of the person who has died.
However, this could result in significant CGT liability for beneficiaries who dispose of assets at a later date, particularly where an asset has been within the family for several generations. There may also be considerable practical difficulties in obtaining historic valuations.
Businesses and farms (APR and BPR)
Business Property Relief (BPR) and Agricultural Property Relief (APR) can reduce the value of certain assets by 50% or 100% for IHT purposes. The OTS suggests that the reliefs are currently worth over £1billion per year.
The OTS recommends that the government should review the requirements of what is considered ‘trading activity’ for BPR claims and consider raising the level of trading activity required. According to the OTS report, consideration should also be given to whether the IHT treatment of furnished holiday lets should be aligned with that of income tax and CGT.
However, raising the level of trading activity required to qualify for BPR could cause difficulties for some business owners. In particular, those with investment assets held as part of a trading group potentially face a charge to IHT that would not otherwise have applied under the current regime.
Under current APR rules, those with farming and agricultural assets can lose the benefit of APR if their circumstances mean that they are forced to leave the farmhouse to go into care. The OTS has recommended that HMRC review their approach to the eligibility of farmhouses for relief in these particularly sensitive cases. This would be a welcome change to the rules which currently penalise those farmers who for health reasons alone are not actively farming right up to their date of death.
Residence nil rate band
One area the OTS report has failed to consider in depth is the residence nil rate band (RNRB). The RNRB was introduced in April 2017 with the idea of enabling individuals to pass the family home to their children free of IHT. The rules are complex and set out specific criteria. For those who do meet the criteria, an additional IHT allowance of up to £175,000 is available. According to HMRC data included in the report, the RNRB takes an estimated 16,450 estates per year out of IHT over the next five years.
However, many people do not qualify for the additional allowance. The OTS consultation received many responses from people expressing concerns that the RNRB is too complex and has a perceived unfairness against those who do not meet the criteria (i.e. by having children or a valuable enough house relative to the value of other assets). Nevertheless, the OTS does not give detailed consideration to the RNRB rules in its report on the basis that the provisions are ‘too new’ and it cannot yet give any recommendations on simplification.
The OTS has missed a key opportunity to review one of the most complex elements of IHT. The report briefly considers the impact of scrapping the RNRB in favour of an increased ordinary nil rate band, but falls short of making any formal recommendations for change. The cost saving from abolishing the RNRB could be used to increase the ordinary NRB for all estates to £376,000 (according to figures in the OTS report). Such an increase would benefit all estates instead of only those meeting the required criteria for the RNRB.
The OTS report includes some positive recommendations and, if implemented by the government, the proposed reforms would represent a major shake-up of the current IHT regime. However, the proposals from the OTS do not go far enough. Piecemeal reforms still make for a complex system and the OTS has missed the opportunity to look at the bigger picture.
With an eye on the political backdrop, it should also be noted that the report was commissioned by the then Chancellor Philip Hammond. The Treasury said it would respond to the OTS recommendations in due course but with the recent changes in government, it is uncertain whether any of the proposed reforms will be implemented or even considered. In the meantime, individuals should keep their estate planning under review to ensure it remains as efficient as possible.
Lorraine Wilson is a Solicitor in Weightmans’ Wills Trusts and Estates Team, if you have any queries regarding this article, please contact Lorraine on 0161 214 0532 or firstname.lastname@example.org.